The oil and natural gas markets are now entering the 2nd year of recovery from the recession that began in late 2014. Historically, market recoveries have accelerated at a faster pace; however, there are certain factors that change the complexion of this recovery.
First, the use of technology and big data are driving down drilling and production costs. Second, the use of longer laterals, some twice as long as those used just a few years ago, ensure that one well can produce as much as three wells, further driving costs down. The use of seismic technology also ensures a greater probability of successful drilling and production. Collectively, these factors enhance well productivity, which drives costs down.
It has been suggested that these changes, along with the proliferation of shale oil production, have created “New Economics” of oil and natural gas. These “New Economics” may challenge the widely heralded assumptions and beliefs of the industry, which includes the price point at which drilling and production is viable.
The U.S. domestic shale markets have altered global supply/demand curves. U.S. shale oil production has acted like a shock absorber for the global oil market. The short lead time between drilling decisions and production means that shale producers can adjust production output very quickly in reaction to world events. However, the new economics of shale producers has also created additional market risks.
The capital structure of shale operators has introduced a new level of risk into the domestic market – financial shocks. Non-shale producers typically can fully or partially fund capital expenditures such as exploration and drilling from current cash flows. However, most shale producers are not well capitalized. As such, shale operators cannot fund operations and capital expenditures from cash flows, thus relying upon external capital (mostly debt) to fund capital expenditures. Shale producers are highly leveraged, creating exposure to financial shocks. This exposure to financial shock is a new dynamic to the industry, and one that will play out in the months ahead as interest rates are poised to rise.
Like most industries, the oil and natural gas industry continues to evolve. New technologies and old players will continue to shape the industry.